Dear Readers,
As you know, I've written a number of articles about the benefits of college savings accounts known as "529 Plans"-- the potential for tax-free growth, estate tax benefits, control over the distributions, flexibility to name a new beneficiary and so forth. (Click on the "Archives" tab in the upper right corner of this page and scroll through the list of past columns. You'll find four articles on this topic since November.)

As I've said before, special privileges granted in Section 529 of the tax code make these plans unique. As you probably know, any asset that you either own or control at the time of your death, is included in your taxable estate. Examples of such items would include stocks, mutual funds, your home, a life insurance policy on yourself which you own, a trust which gives you power to distribute money or change the beneficiaries, and so forth.

The only asset not included is a 529 Plan.

This year, if your taxable estate exceeds one million dollars, it is subject to estate tax of up to 50%. Let me say this another way: a 529 Plan is the only account in America where someone can give away (i.e. "gift") assets during their lifetime, control them until the day they die and potentially have them excluded from their taxable estate, thus avoiding estate taxes upon their death.

This makes the 529 Plan not just (in my opinion) the smartest way to save for a child's college education. It also makes it a powerful estate-planning tool.

However, all of your good intentions to help defray the cost of a child's education can be derailed if Medicaid is brought into the picture. Medicaid is a hybrid: a combination federal-state program aimed at helping the elderly poor pay for catastrophic medical costs such as nursing home care. Funding comes from both the federal government and each state.

While there are federal guidelines as to how the money is to be distributed, states have considerable leeway to interpret and implement the rules.

For instance, within the guidelines, each state gets to decides how "poor" you have to be in order to qualify. This essentially means you have to use up most of your own assets to pay for your care until Medicaid kicks in. In the state of Ohio, for instance, if you are unmarried and over age 65, you must "spend down" your assets-- including your home-- until you have only $1500 left. Then you are eligible for Medicaid assistance.

The rules are a bit less draconian for a married couple because the government doesn't expect your spouse to be left homeless and penniless. Using Ohio as an example again, if one member of a couple applies for Medicaid, the home is not included in your "spendable" assets provided your spouse is living in it. You are expected to spend at least half of your other assets so that your spouse is left with no more than $89,280. (Don't ask me where they come up with these numbers.)

Medicaid doesn't just look at the assets you own at the time you apply for assistance. These folks aren't dummies. They know what you're thinking: "Fine. I'll just transfer virtually everything I own to my kids. That will enable me to keep the money in the family while at the same time reducing my assets down to the Medicaid limit so I can qualify for government assistance."

Nice try. To determine whether you meet the guidelines, Medicaid can look back three years to calculate what you're worth. Gave your son that $50,000 CD two years ago and he spent it on a second home? Too bad. Figure out a way to cover $50,000 worth of expenses yourself before Medicaid coughs up a cent.

Now here's the problem scenario as it relates to 529s:

Grandpa opens a 529 College Savings Plan for his 3-year old granddaughter, Suzie, and names himself the owner/controller of it. Over the years he contributes $30,000 to this account. Suzie's parents and other relatives also make contributions in lieu of expensive birthday and holiday gifts.

At age 17, Suzie's college fund has grown to $60,000. She has most of her college education covered. Not!

At the age of 85, Grandpa is in an advanced stage of Alzheimer's disease. Instead of the assisted living care he's been receiving up to now, Grandpa needs full-time nursing home care, which averages $50,000 a year in his part of the country. While Grandpa was always a thrifty man, he was never a wealthy one. Much of the money he received from the sale of the family home and his investments has already gone to pay for his assisted living care. After investigating the Medicaid regulations in Grandpa's state, his son applies for Medicaid on his behalf.

Medicaid's probable response: before you get a dime from us, you have to spend most of your own assets to defray the cost of your care. And since you control your granddaughter's 529 account, that means we expect you to use that money to pay for nursing home care. There goes Suzie's college fund.

According to Armond Budish, a Cleveland attorney who specializes in Medicaid cases, "If an applicant can reach an asset, they're expected to use it unless it's an exception." At this point, 529 plans are not a federal exception. Ideally, says Budish, the federal government would pass legislation specifically making 529 plans off-limits in terms of Medicaid. There already exists such a regulation concerning an immediate annuity (except in Pennsylvania, Ohio and New Jersey).

But until and unless that happens, it will be up to each individual state to decide how it will handle these accounts. So far, not a single state has taken the steps necessary to protect 529 college savings accounts from Medicaid, according to CPA Joe Hurley, who maintains a Web site on 529 plans, Savingforcollege.com.

Fortunately, there's a simple solution to this dilemma: Grandpa makes the contributions to Suzie's 529 College Savings Account, but names someone else-- his son, say-- as the owner/controller of the account. This enables Grandpa to get the money out of both his taxable estate and his Medicaid estate.

If the account isn't set up this way initially, then have Grandpa transfer ownership of the account to his son at least three years before he thinks he might need to apply for Medicaid.

Think this is unfair? Let your state representatives know how you feel.


If you have a question for Gail Buckner and the Your $ Matters column, send them to moneymatters@foxnews.com  along with your name and phone number.

The views expressed in this article are those of Ms. Buckner or the individual commentator, and do not necessarily reflect the views of Putnam Investments Inc. or any of its affiliates. You should consult your own financial adviser for advice regarding your particular financial circumstances. This article is for information only and is not an offer of the sale of any mutual fund or other investment.